Outlook For Regional Banks: Positive
Tuesday, June 22, 2021 5:05 PM

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The fundamental outlook for the regional banks sub-industry for the next 12 months is positive. Credit quality is expected to improve at a significant pace, and 2010 earnings benefit from much lower loan loss provisioning expenses than previously expected. While credit quality of commercial lending is still declining, the rate of this decline is much slower than expected earlier this year. This rate will be slow enough that many banks will not have to raise additional equity capital this year. Total loan loss provisions are expected to peak in mid-2010 and gradually decline in the second half, even though industry wide provisions are likely to be significantly less than net charge offs this year or next, especially for the largest banks. Also, unrealized losses on securities are reversing this year, and the securitization market continues to open up.
 
The better capitalized banks, especially those no longer in the TARP plan, are expected to consider the possibility of share buybacks and/or dividend increases.
 
The chief overhang for the banking industry in 2010, is loan growth, which is still negative for most banks, and which has declined, on a sequential basis, in each of the past several quarters. On first quarter earnings conference calls, bank managements were extremely cautious about loan growth in 2010. Many categories of loans, such as commercial and residential construction, will likely not see any growth in 2010. However, as the U.S. economy improves, some growth in 2010 in commercial lines of credit, mortgages on existing properties, and leasing activities is likely. Also, based on retail and manufacturing data, the risk of a double-dip recession is much lower than it was a quarter ago.
 
Year to date through May 28, on a total return basis (including dividends), the S&P 1500 Regional Banks Index increased 21.7%, versus a 1.5% decrease for the S&P 500 Stock Index.
 
Current bank-stock valuations are discounting the uncertainty created by the European debt crisis, the financial-reform bill (Financial Regulation) and the Gulf oil slick.
 
While headline risk is likely to remain elevated near term, increasing volatility, current valuations offer an attractive entry point to investors based on the view that despite the near-term headwinds, the U.S. economy is likely to continue on its path of slow and steady recovery and clarity on the above issues should serve as a positive catalyst for bank stocks.
 
As for the Financial Regulation bill, the most onerous provisions are likely to be watered down by the time the final bill is passed. While the impact on the economy (particularly the Southeast economy) from the Gulf oil slick is hard to handicap at this point, beyond the direct impact to the tourism and fishing industry, we could also see some near-term headwinds for the energy industry due to the administration's six-month moratorium on deepwater-oil drilling.
 
We favor value versus growth and believe that banks that are currently trading closer to 1.0 times year-end 2010 tangible book values (TBVs) and where capital and credit issues have been addressed, provide the most attractive risk/reward. We see considerable upside in banks where we believe credit issues have peaked and the banks are on their way to returning to sustainable profitability.
 
We would be buyers of Marshall & Ilsley (MI), Zions Bancorp (ZION), SunTrust Banks (STI), Texas Capital Bancshares (TCBI), Huntington Bancshares (HBAN), Fifth Third Bancorp (FITB), BB&T (BBT) and Synovus Financial (SNV), given the relatively attractive valuations and based on the view that these banks should lead peers in terms of continued credit improvement and a rebound in earnings.
 
While Synovus at 1.1 times TBV and SunTrust at 1.2 times TBV appear attractive longer term, we remain somewhat cautious due to their Florida exposure, given the uncertain impact from the Gulf oil slick that could dampen the overall Florida economic recovery.
 
Fundamental improvement driven by lower credit losses and expanding net interest margins coupled with strong capital and reserve ratios have positioned the banks in a relatively healthy position to deal with near-term headwinds.
 
With short-term interest rates unlikely to move near term, bank net-interest margins should continue to expand or remain relatively stable in the coming quarters. While loan demand has been sluggish so far, demand is expected to pick-up (albeit at a slow pace) in the second-half of 2010 driven by equipment financing need followed by accounts receivable, inventory build, etc.
 
The passage (likely by July 4) of the Financial Regulation legislation could serve as a positive catalyst for bank stocks as it would provide the much-needed clarity on several key issues for bank-stock investors. Final capital levels may still remain unknown until the international rules are set (likely by year end) under the Basel III rules. However, key provisions such as Lincoln (derivatives/swaps), Collins (trust-preferred securities), Durbin (interchange legislation) and a few others are likely to be watered down by the time the final legislation is passed.
 
With the Federal Deposit Insurance Corp. steadily scaling back assistance on failed bank transactions and given the significant competition from buyers during recent failed bank bids, increasing signs for a return to regular mergers-and-acquisitions activity over the next 12 months are evident. The recent (announced May 17) acquisition of South Financial Group (TSFG) by Toronto-Dominion Bank (TD) was done without any credit guarantees (although the Treasury did take a haircut on its Troubled Asset Relief Program [TARP] investment).
 

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